EU Puts Periphery Countries on the Rack

For those of you unfamiliar with medieval implements of torture, the rack was believed to be quite effective in extracting information, but generally by having a potential victim watch it in use, with the obvious threat that he was next unless he cooperated. The rack was not only terribly painful, but like most old school methods of torture, often crippled those who survived. (Civilized people, which now clearly excludes our President and those in influential positions in the Pentagon, now recognize that torture is good only for producing phony confessions). It was also employed in particularly gory executions, such as drawing and quartering.

The Eurozone seems to be using similar medieval methods on its debt-laden periphery countries with far less clear understanding that serious damage to the subject is a likely outcome. However, we have the unusual spectacle of a smidge of disagreement between two regular critics of the Eurozone “kick the can down the road and call it a strategy” approach to its interwoven sovereign debt/banking crisis. The trigger event was an announcement over the weekend of yet another adjustment in the funding mechanisms for countries at risk of default: an enlargement in the size of the rescue facility, a 1% reduction in punitive interest rates, some loosening of restrictions on the uses of the €440 billion facility (limited purchase of periphery country debt permitted). But numerous conditions were imposed on the subject countries. Ireland refused to accept the new terms because it would have had to give up its low corporate tax rate.

One of the two skeptics, Wolfgang Munchau of the Financial Times, simply sounds resigned to an eventual train wreck. His reading is straightforward: there are only two mechanisms for resolving a debt crisis, namely a bailout or a default (or a combination). I actually disagree a tad, since the options are really “provide new funds” which might not be nuts if debt were written down enough, a voluntary restructuring, or a default. But his bottom line is right: the Europeans are engaged in what we call “extend and pretend” and for countries like Greece, the only possible endgame is default:

This game will continue until the debtor country’s economy collapses under its debt burden, at which point the inevitable default will be very messy. If you are lucky, you are no longer in office by then, and you can blame your successor for the mess.

So what to do instead? You could either accept the logic of a default, and arrange for it now, followed by a big programme for bank bail-outs, a recapitalisation of the European Central Bank, and credit support for the defaulting country. Or else, you accept the principle of a bail-out, not through cross-country transfers, but a single European bond that replaces all national debt. I personally would choose that option. A large and highly flexible rescue mechanism with pari passu status, the ability to underwrite debt or buy bonds in secondary markets, would have been a step in that direction.

Ms Merkel said at her press conference that her one concession – for the ESM to be able to buy bonds in primary markets – is not going to make much of a difference. She is right. The rescue mechanism as constructed now is an emergency facility only. On Saturday morning, the EU got itself an arrangement that lives in a purgatory between bail-out and default, as it muddles through a never-ending crisis.

Ambrose Evans-Pritchard, by contrast, is even more worked up than usual, which for him is saying quite a lot. He instead focused on the demands being made of the periphery countries and finds them to be untenable. Our Richard Smith reached a similar conclusion for Ireland, but pointed out they may have ways of extorting the Eurozone members:

Wonder if the Irish will default now. Or just publish, instead of stupid coverup stress test results, really horrific ones that show another EUR100Bn is needed; somewhat the technique of Calcutta beggars displaying running sores for extra horror and pity.

I think that would do more than engender a shudder in viewers; it would call unseemly attention to what a sham the bank stress tests are and could produce some unexpected reactions (if nothing else, from the officialdom, which believes everyone believes their BS, when the markets are up mainly on the expectation of continued central bank munificence).

One part I find particularly alarming, as I suspect subject states will, is the demand for infrastructure sales. Per Evans-Pritchard:

For Greece, the terms are a fire-sale of €50bn (£43.2bn) of national assets within four years, a tenfold increase from the original €5bn that premier George Papandreou thought he signed up to a year ago.

When the IMF first mooted this sum last month he told the inspectors not to “meddle in the internal matters of the country.“

State holdings in Hellenic Post, Hellenic Railways, Athens Public Gas, the Pireaus port authority, Athens airport, Thessaloniki water, and ATEbank, to name a few, will not fetch more €15bn. What next?…

Meanwhile, austerity is biting harder. The jobless number jumped almost a full point to 14.8pc in January. Youth unemployment hit 39pc.

For Portugal, the condition is more hairshirt retrenchment, a fiscal squeeze of 5.3pc in one year. Pensions, welfare, and health will be cut, following wage cuts already under way. “A descent into Hell,” said the Bloco de Ezquerda.

Almost 300,000 youth took to the streets of Lisbon and Oporto on Saturday in a day of wrath by the “Desperate Generation”, openly invoking the events of Egypt’s Tahrir Square…

The condition for Spain, Italy, Belgium et al, is intrusive surveillance of pensions, wage policies, productivity levels, as well as demands for a mandatory “debt-brake”, regardless of whether or not such a reactionary policy implies 1930s deflation.

Just as eurosceptics always feared, monetary union has led to a state of affairs where – in order to “save the euro” as Mrs Merkel puts it – Europe’s ancient states find themselves having to accept a quantum leap towards political union and a degree of subjugation that would not have been tolerated otherwise.

There is no democratic machinery to hold this central system to account since the European Parliament lacks a unifying language or demos, and remains a technical body in practical terms.

So we have an unelected body and a German iron maiden calling the shots. And as Evans-Pritchard’s mention of Tahir Square suggests, he believes the public will revolt. He notes that in the Great Depression it took three years for severe economic location to translate into protests. It’s likely to move faster, given the emboldening examples of revolts in the Middle East (although Egypt had years of organizing behind it) and the widespread recognition that citizens are being squeezed to preserve the balance sheets of German and French banks.

It’s important to note that the big culprit in Greece’s deficits has been its military spending, which historically was just below Israel’s, with arms purchased from the US, Germany, and France. The logic was to curry favor with influential patrons in its long-running dispute with Turkey. But purchased loyalty clearly does not run very deep.

A colleague of mine spoke to a friend in Greece, and he says matters on the ground are worse than reported in the media. Unemployment among recent graduates is 70% as far as he can tell (!) and civil disobedience is widespread. The favorite target is tolls. One person lifts up the bar while the driver proceeds through the station. And the logic is impeccable: if everyone disobeys, the powers that be cannot enforce. Any effort to do so would be capricious and would clog up the courts.

But high levels of unemployment among the young is the perfect tinder for more widespread protests. And as Evans-Pritchard points out, the creditor states cannot lay legitimate claim to the moral high ground:

The tenor is cruelly one-sided, as if this were a morality tale of wise and foolish sovereign virgins. The debtor states are made to carry opprobrium for what is at root a pan-European banking crisis.

Ireland and Spain never breached the deficit ceiling of the Stability Pact, though Germany and France did. They did not break the rules. If anything, it was the European Central Bank that broke the rules by running negative real interest rates and gunning the money supply.

In the end, default by Greece and Ireland is inevitable, and austerity policies that produce deflation will push more countries into default or restructuring. But as Munchau has repeatedly pointed out, the current wishful thinking among the Eurozone officialdom is that a crisis deferred is a victory, when it instead guarantees a worse explosion when the bomb finally goes off.